What loan is best for you?

AT the end of March industry regulator Australian Prudential Regulation Authority (APRA) wrote to Australia’s lenders to ask them to limit their level of interest-only lending to 30 per cent of all new residential home loans.

As a result, many of Australia’s lenders started to tweak their interest-only pricing and policies, says Mortgage Choice.

Some lenders actually lifted the interest rates on these products by as much as 35 basis points, while other lenders made it clear that they would no longer give owner-occupiers interest-only loans without good reason.

So what do all these changes mean for both owner-occupiers and investors?

Before we answer that question, it might be prudent to first describe the difference between interest-only and principal and interest loans.

Interest-only

As the name suggests, with an interest-only home loan, you pay only the interest charged on the loan. In other words, throughout the entire interest-only period, you do not pay down the principal debt at all.

Generally speaking, most lenders will only allow you to have an interest-only loan for a certain period of time (up to five years). After that time, you can either switch to a principal and interest home loan or commit to another interest-only period (depending on your situation and lender).

With an interest-only loan, your regular repayments are reduced (because you are paying only the interest charged on your home loan debt).

This type of loan is also very popular with investors because they do not necessarily want to pay down their mortgage debt so as to maximise their tax deductions.

Principal and interest

With a principal and interest loan, your repayments are divided up into two portions.

Some is used to pay off the interest due on your outstanding loan amount, while the remainder goes towards paying off the outstanding loan amount itself.

For owner-occupiers, it’s often preferable to have a principal and interest product, where possible.